Types of Valuation Multiples

What are valuation multiples?

Valuation multiples are financial measurement tools that evaluate one financial metric as a ratio of another, in order to make different companies more comparable. Multiples are the proportion of one financial metric (i.e. Share Price) to another financial metric (i.e. Earnings per Share). It is an easy way to compute a company’s value and compare it with other businesses. Let’s examine the various types of multiples used in business valuation.

What are the different types of valuation multiples

There are two main types of valuation multiples:

Equity Multiples

Enterprise Value Multiples

There are two main methods of performing analysis using multiples:

Comparable Company Analysis (“Comps”)

Precedent Transaction Analysis (“Precedents”)

Advantages and disadvantages of valuation multiples

Using multiples in valuation analysis helps make sound judgments for analysts and companies. This is especially true when multiples are used appropriately because they provide valuable information about a company’s financial status. Furthermore, multiples are relevant because they revolve around key statistics related to investment decisions. Finally, the simplicity of multiples makes them easy to use for most analysts.

However, this simplicity can also be considered a disadvantage because of the fact that it simplifies complex information into just a single value. This simplification can lead to misinterpretation and makes it challenging to break down the effects of various factors.

Next, multiples represent a single instance of a company’s status rather than a period of time. As such, they do not easily show how a company grows or progresses. Additionally, multiples reflect short-term data instead of long-term ones. Thus, the resulting values may only be applicable on the short-term and not in the longer future.

Price/Book Ratio – useful if assets primarily drive earnings; computed as the proportion of Share Price to Book Value Per Share

Dividend Yield – used for comparisons between cash returns and investment types; computed as the proportion of Dividend Per Share to Share Price

Price/Sales– used for firms that make losses; used for quick estimates; computed as the proportion of Share Price to Sales (Revenue) Per Share

However, a financial analyst must take into account that companies have varying levels of debt that ultimately influence equity multiples.

#2 Enterprise Value (EV) multiples?

When decisions are about mergers and acquisitions, enterprise value multiples are the appropriate multiples to use. The list below shows some common enterprise value multiples used in valuation analyses.

EV/Revenue – slightly affected by differences in accounting; computed as the proportion of Enterprise Value to Sales or Revenue.

EV/EBITDAR – most used in industries in the hotel and transport sectors; computed as the proportion of Enterprise Value to Earnings before Interest, Tax, Depreciation & Amortization, and Rental Costs

EV/EBITDA – EBITDA can be used as a substitute of free cash flows; most used enterprise value multiple; computed as the proportion of Enterprise Value to Enterprise value / Earnings before Interest, Tax, Depreciation & Amortization

EV/Invested Capital – used for capital-intensive industries; computed as the proportion of Enterprise Value to Invested Capital

There are more equity and enterprise value multiples used in company valuation, this article only presented the most common ones. More readings and a thorough understanding of each multiple and related concepts can help analysts better apply multiples in making financial analyses.

Methods of using multiples

All of the above metrics can be analyzed with two common approaches to valuation multiples:

Comparable Company Analysis – This method analyzes public companies that are similar to the company being valued. An analyst will gather share prices, market capitalization, capital structure, revenue, EBITDA, and earnings for each company. Learn more about performing comparable company analysis.

Precedent M&A Transactions – This method analyzes past mergers and acquisitions (M&A) for companies in the same industry, which can be used as a reference point for the company that is being valued. Learn all about performing precedent transaction analysis.